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Avoiding Penalties on Retirement Withdrawals

Audio version available here (2 min.)

If you are not yet at retirement age (59 ½) but need to take money out of your retirement account, you may incur an early withdrawal penalty. This is typically a 10% tax imposed on the taxable amount of the money you withdraw, but in some circumstances, the tax can be as high as 25%. This may discourage you from withdrawing money when you’re in a pinch, but there are actually a few exceptions to the penalty.

One major exception is for medical expenses. If you pay medical expenses that total more than 7.5% of your adjusted gross income (AGI) with money withdrawn from your IRA or 401(k), you are likely to be exempt from the 10% penalty. The catch is that you must receive the money from your retirement account the same year you pay the medical expense.

Another major exception is Substantially Equal Periodic Payments. These are recurring annual withdrawals from your retirement savings before you hit retirement age, but you need to be careful if you decide to take them on. If you calculate each annual payment amount incorrectly, or ever change the amount withdrawn, the IRS can impose a retroactive penalty on each withdrawal. These payments also take commitment. There is a 5 year minimum to taking periodic withdrawals, or you must reach 59 ½ years old, whichever takes longer.

There are several more exceptions, like a once-a-year $1,000 personal emergency expense withdrawal, a once-a-lifetime $10,000 qualified acquisition costs withdrawal for a home, and a $22,000 limit for disaster recovery. There are also exceptions for military reserve members called to active service, domestic abuse survivors, unemployed individuals’ health insurance premiums, those who are disabled, need long-term care, are terminally ill, or have passed away.

When deciding to make early withdrawals from your retirement account, it’s important to consult a financial advisor or tax professional, even if you believe you qualify for any of these exceptions. If for whatever reason you end up not qualifying for the exception, the IRS could impose penalties on you. Avoid this by speaking with an expert before you take any action. You can easily reach one with XQ CPA. Simply give us a call or book online for a consultation today.

Phone: 832-295-3353

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Want to pay less taxes? Read XQ CPA's official tax planning guidebook! How to Grow Your Wealth Through Tax Planning.

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